Detailed Directors’ Duties

Introduction

Lets look into the main fiduciary duties of directors, which have for the first time been listed in the new Companies Act 2014. Directors also have other duties imposed via the Companies Act, like the duty to file accounts on time, but here we are looking at the broader duties and look at examples of the types of situations where those duties could be breached.

It is important to note that a director has fiduciary duties to the company whether they are an executive director (i.e. working for the company day-to-day) or a non-executive director.

Directors of Irish companies are bound by duties to:

act in good faith

act honestly and responsibly

act in accordance with the company’s constitution and to exercise those powers only for lawful purposes

not use company property unless approved by the members or the company constitution

not fetter discretion unless permitted by the constitution or unless it’s in the company’s interest

avoid conflicts of interest

exercise care, skill and diligence and

have regard for the interests of shareholders as well as employees

Act in good faith

A Director must act in good faith in what the director considers to be the interests of the company. The duty is subjective, so the director must act in what he or she believes to be the interests of the company. Just because another director, manager or even the courts may not believe that a certain course of action was in fact in the interests of the company, doesn’t take away from the fact that the director him/herself may have genuinely believed the action to be in the best interests of the company. Two directors can legitimately have different, honestly-held, opinions as to what is in the best interests of the company.

“The duty imposed on directors to act bona fide in the interests of the company is a subjective one…The question is not whether, viewed objectively by the court, the particular act or omission which is challenged was in fact in the interests of the company; still less is the question whether the court, had it been in the position of the director at the relevant time, might have acted differently. Rather, the question is whether the director honestly believed that his act or omission was in the interests of the company. The issue is as to the director’s state of mind. No doubt, where it is clear that the act or omission under challenge resulted in substantial detriment to the company, the director will have a harder task persuading the court that he honestly believed it to be in the company’s interest; but that does not detract from the subjective nature of the test.“[1]

The duty to act honestly has both objective and subjective elements. Objectively, has the director acted as an honest person would? Subjectively, has the director acted as an honest person would under the circumstances?

“Honesty, indeed, does have a strong subjective element in that it is a description of a type of conduct assessed in the light of what a person actually knew at the time, as distinct from what a reasonable person would have known or appreciated. Further, honesty and its counterpart dishonesty are mostly concerned with advertent conduct, not inadvertent conduct. Carelessness is not dishonesty. Thus for the most part dishonesty is to be equated with conscious impropriety. However, these subjective characteristics of honesty do not mean that individuals are free to set their own standards of honesty in particular circumstances. The standard of what constitutes honest conduct is not subjective. Honesty is not an optional scale, with higher or lower values according to the moral standards of each individual. If a person knowingly appropriates another’s property, he will not escape a finding of dishonesty simply because he sees nothing wrong in such behaviour”[1]

Act in accordance with the company’s constitution and to exercise those powers only for lawful purposes

This requires directors to be aware of the company’s constitution and to exercise their powers in the interests of the company only.

A common example of where this has been examined by the courts is where the directors vote to allot shares such that the control of the company is changed, or such that a person who had previously held a sufficient percentage of shares to block certain actions no longer holds that percentage.

Example:

Three founders start a company with equal shareholding (33% each). Things go well for a while but eventually the company runs into difficulties and needs either outside investment or needs to dramatically cut costs. Attracting outside investment, if successful, will increase the chances of company growth, whereas cutting costs will likely enable the company to continue to trade, but will severely limit growth potential in the medium term. Two directors are (in good faith) in favour of securing outside investment and the third director is (in good faith) against the notion. While the term sheet presented by the investor proposed that the investor would take up 25% of the post-money share capital (leaving the three founders and the investors each holding 25% each), the investors and two first directors agree between themselves to increase the investors holding by a few shares, enough to make sure that the third director no longer holds 25% of the share capital (the percentage required to block certain corporate actions). Even though the two directors may believe that it is in the best interests of the company that the third director no longer has that level of control in corporate decisions, if the arrangement made with the investor was purely to reduce the shareholding position of the third director, that would not be a good faith exercise of their powers.

Example:

A non-executive director’s contract of service has a term of 2 years, consistent with provisions in the company’s constitution that directors must rotate every two years. The board, in good faith and in the interests of the company, subsequently enters into a new contract with the non-executive director extending their arrangement for another year. This would be a breach of the duty to act in accordance with the company’s constitution. Such a change to the non-executive director’s agreement would require either shareholder consent or an amendment to the constitution to permit a 3+ year term.

Not to use company property unless approved by the members or the company constitution

A director cannot use the company’s property, information or opportunities for his or her own, or anyone else’s, benefit unless this is expressly permitted by the constitution or approved by the shareholders. Directors cannot use or benefit from company property, including business opportunities, by using them themselves or for other third parties, unless properly approved.

Example:

A director has “donated” a personal printer to the company for its use. The director (in good faith) believes that the printer is worth €400 but did not request payment from the company. The company has an expensive camera that it no longer uses, which, on eBay, is likely worth €400. The director borrows the camera but gets used to it and never returns it. This is an unacceptable use of company property.

Example:

A director of a high-quality design company is also chairperson of a local charity. The charity is holding a fundraising event and the director needs to design and print glossy flyers to distribute to the community. The director asks for assistance from one of the company’s graphic designers to design the flyers during work hours and on the company’s computers using the company’s expensive design software. The director also uses the company’s printers to produce the flyers. Both the repurposing of the graphic design employee’s time and the use of company equipment to product the flyers is an improper use of company property. In order to be OK, it would have to be approved in advance by the company’s shareholders.

Example:

A company is in the process of being acquired in a share-for-share transaction by a publicly quoted company. The company’s board has been provided with the acquiring company’s strategic plan and unpublished financial information, showing a projected profit in excess of market expectations. A company director uses this information to purchase shares in the publicly quoted company and makes a large profit after its next earnings announcement. While the director’s actions may well be in breach of relevant insider dealing regulations, the use of information provided to the company for his/her own benefit is also a breach of the director’s duties to the company.

Not to fetter discretion unless permitted by the constitution or unless it’s in the company’s interest

A director must use independent judgment, uninfluenced by outside factors, unless it’s permitted by the constitution or the director believes in good faith that, to do so is in the best interests of the company.

In some cases it will be in the company’s interests to agree to do something or to avoid from doing something in the future.

Example:

A shareholders agreement presented by a potential investor will likely contain terms requiring the directors to act in accordance with the agreement. While this may appear to be a future agreement to fetter discretion (i.e. to mandate how a director should exercise his or her judgment), if the original agreement is entered into in good faith for the benefit of the company and is approved by the requisite majority of shareholders, the requirement to act in accordance with the terms of the agreement will not be judged to be an unlawful fettering.

Example:

A CEO director is seeking to hire a new VP Sales. The CEO identifies a candidate and they agree terms before submitting the approval of the hire to the board. In an email, the CEO tells the candidate that he/she will vote in favour of their appointment at the next board meeting. Between the time of this email and the time the board meets to consider the appointment, the board discovers a new, better, candidate for the position. The CEO, acting as a director, must act in the best interests of the company and must support the best candidate for the job.

To avoid conflicts of interest

A director should avoid any conflict between the director’s duties to the company and his/her other interests (including personal interests) unless the constitution permits it or if the conflict and action has been disclosed to and approved by the shareholders. At a board meeting, if a director has a potential conflict, the usual course of action is for that director to declare the conflict at the beginning of any board meeting at which the matter is to be considered and to abstain from voting on any applicable proposal.

Example:

A director is a shareholder of another company which is a supplier to the main company. The company has had major problems with the supplier and is considering suing the supplier for damages. At any meeting at which this matter is considered, it is appropriate either for the conflicted director to not attend the meeting or, if he/she does attend, to declare the conflict at the beginning of the meeting and also to abstain from voting on any proposal to sue the supplier.

Example:

The company is short-handed during a tradeshow. A director’s partner (a “connected person” per the relevant legislation) is available and qualified to provide support during the period of the tradeshow. The partner would be paid no more than any other candidate for the position. While in this case it is difficult to see how the company could suffer damage as a result of giving the director’s partner a temporary job, it is good practice to make the board aware of the appointment and is best practice to approve it at a board meeting (or ratify it after the event).

To exercise care, skill and diligence

This standard has both objective and subjective elements. A director will be expected to use the same level and skill as a reasonable person would expect (objective) from a person with the same knowledge and experience as the director actually has (subjective).

For example, a director who is an accountant will be expected to exercise the same skill as a reasonable person who is an accountant, which will be a greater level of skill in the realm of accountancy than a software engineer director who has little financial experience. Note that the subjective nature of this test does not mean that a non-accountant director can ignore the financial aspects of the business, it means that the accountant director will be held to a higher standard of skill. A software developer director, on the other hand, will be expected to have a higher level of skill and knowledge about those strategic, technical decisions required to be made by the board and, in that situation, the accountant director will not be expected to know, or to have to learn, the minute detail behind the technical elements of the decision.

To have regard for the interests of members (shareholders) as well as employees

It is ok to have regard to various parties’ interests but directors are still be required to act in the best interests of the company. If a certain result can be achieved in one or more ways, the way which is in the best interests of the employees is preferable. A very simple example would be if a company received acquisition offers from two potential buyers. The terms of the offers are largely the same but the second offeror has stated clearly that it intends continuing the company’s operation in whole after the acquisition. The first company has been equivocal on this point and has given themselves broad freedom to close the company’s business unit down and move willing staff to another location. With all other things being equal, the second acquisition offer is in the best interests of the employees and so should be the one chosen.

Some more examples

Example 1

Let’s say you are a founding member of a company with two other people; you each own 33% of the company as shareholders and you are all on the board of directors. You all come from technical backgrounds and so are concentrating your work on the technical side of the business. You realize that, in order to receive funding for the company (i) one of your number needs to step up to the position of CEO (ii) you will need to hire another person e.g. a sales person, in order to close a deal you’ve been working on and (iii) you don’t have enough money to hire the sales person and keep the current level of salary for all three founders. What is suggested is that (i) the founder-to-CEO’s salary will remain the same (ii) the sales person will receive a modest salary but, in order to fund this (iii) the remaining two founders will need to take a salary cut of 50% for a limited period of time.

As employees, the two founders might feel rightfully put out. As directors, however, they may see that, in order for the company to succeed, these measures are necessary in order to keep the company going. The directors act for the benefit of the shareholders; the shareholders may end up with nothing if the company runs out of cash before a deal is signed.

The two founders may also believe that the CEO should also take a salary cut, but the key question to ask is if they believe that out of a general sense of (un)fairness or if they truly believe that it is in the best interests of the company that all founders take equal salary cuts.

Example 2

An external director is also a skilled and experienced financial consultant. The director has provided excellent financial services for free for the first six-months of his/her involvement with the company. The company then receives funding and the directors all agree that the financial consultant director should be paid for his/her time in the future for giving advice outside the scope of his/her directorship. The financial consultant director submits a quote which is 120% of his/her normal rate for the type of work required, believing that he/she is rightfully entitled to be compensated for all the hard work done in the first 6 months. The other directors are not aware of this and believe the rate to be fair. The financial consultant director has breached his/her duties of good faith in this instance by increasing the rate for an impermissible purpose and by not informing the other directors. Even if the financial consultant did inform the directors, it is hard to justify any decision to approve an enhanced rate purely for historical services rendered if there was no understanding at the time that the financial consultant would be paid.